Refinancing your Property Rental Businesses
Where you have one or more properties that are let out to third parties on a commercial basis, you are regarded as carrying on a "property rental business". Interest paid on loans taken out for the purpose of purchasing or improving a property that is part of a property rental business is fully deductible for tax purposes against the rental income. By contrast, interest paid on loans used to purchase a private residence is not deductible for income tax purposes. Given the recent spike in property prices, it is tempting to refinance a loan on a property that is let out and use the proceeds to reduce the loan on your private residence, thereby maximising the deductibility of your total interest bill for tax purposes. Does such a strategy work?
The answer is maybe! Where you have just one property in your property rental business, then the maximum loan on which you can claim interest relief is the higher of a) the original cost plus improvements and b) the market value at the date you first started letting the property. By way of example, if you purchase a property for £400,000 plus £12,000 stamp duty land tax plus legal fees of £3,000, and then spend £10,000 on capital improvements, and you then immediately start letting the property, then the maximum loan on which interest relief can be claimed is £425,000. If the original loan taken out to acquire the property was £300,000, then the full amount of interest paid on such a loan would be tax deductible. Let's now assume that the property is worth £1mn, and you refinance the loan up to £600,000, and use the surplus to reduce your private mortgage. Since the maximum amount on which you can claim relief is £425,000, you will only get interest relief on 425/600 of the interest paid.
By way of a second example, let's assume the same facts as above but that you lived in the property for a few years before letting it out. The value of the property when you first started letting it was £700,000 and since this is higher than the £425,000 spent on its acquisition and improvements, then this is now the maximum size of loan on which interest relief can be claimed. If the loan is refinanced up to £600,000 then the full amount of interest paid would be eligible for relief since it is below the £700,000 maximum as determined by the market value of the property at the commencement of letting.
Where you have more than one property in the property rental business, then it is possible to aggregate the position for all of the various properties to determine the maximum amount of loans on which interest relief can be claimed. So let's carry on with our first example above (i.e. with no personal occupation), but assume there is a second property in the business which was acquired for £500,000 inclusive of all costs and against which there is a loan of £300,000. In these circumstances, the maximum loans on which the property rental business can claim interest relief are £425,000 in respect of property 1 and £500,000 in respect of property 2, a total of £925,000. If the first property is refinanced up to £600,000, then the total loans outstanding are then £900,000 which is below the £925,000 maximum, and therefore the full amount of interest on all the loans will be eligible for relief. This is despite the fact that the total borrowings on property 1 exceed the maximum amount that would be eligible for relief if it were a stand-alone property.
For more information on this topic please contact Gavin or call us 020 8545 7600.